China Conch Venture: All Eyes On Planned Spin-Offs

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I assign a Neutral rating to Hong Kong-listed Chinese conglomerate China Conch Venture Holdings Ltd. (OTCPK:CCVTF, 586:HK).

China Conch Venture is a conglomerate which derives the majority of its earnings and value from its 17.8% indirect stake in a listed cement company. Its financial performance in 1H 2020 was strong, but there are certain weak spots that are noteworthy, such as declining operating cash flow on a YoY basis and gross margin contraction for the solid waste solutions business.

China Conch Venture also has plans to spin off its solid & hazardous waste treatment business and waste-to-energy/power generation business in the next few years, which could potentially narrow the conglomerate discount assigned to the stock. However, it is always possible that the planned spin-offs are either delayed or their implied IPO valuations fall short of market expectations.

I see a Neutral rating for China Conch Venture as justified, taking into account the above-mentioned factors.

Readers have the option of trading in China Conch Venture shares listed either on the Over-The-Counter Bulletin Board/OTCBB as ADRs with the ticker CCVTF or on the Hong Kong Stock Exchange with the ticker 586:HK. For those shares listed as ADRs on the OTCBB, note that liquidity is low and bid/ask spreads are wide.

For those shares listed in Hong Kong, there are limited risks associated with buying or selling the shares in terms of trade execution, given that the Hong Kong Stock Exchange is one of the major stock exchanges that is internationally recognized, and there is sufficient trading liquidity. Average daily trading value for the past three months exceeds $18 million, and market capitalization is above $8.5 billion, which is comparable to the majority of stocks traded on the US stock exchanges.

Institutional investors which own China Conch Venture shares listed in Hong Kong include The Vanguard Group, BlackRock, Baron Capital Management, and Aberdeen Asset Managers, among others. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers and Fidelity, or international brokers with Asian coverage like Hong Kong’s Monex Boom Securities and Singapore’s OCBC Securities.

Conglomerate With Majority Of Earnings And Value Derived From Stake In Cement Company

China Conch Venture is a conglomerate with interests in multiple businesses such as energy preservation and environmental protection solutions, building materials and port logistics services. More importantly, the company derives the majority of its earnings and value from its 17.8% indirect stake in Hong Kong-listed Chinese cement producer Anhui Conch Cement (OTCPK:AHCHY, OTCPK:AHCHF, 914:HK). China Conch Venture owns a 49% stake in non-listed holding company Conch Holdings, which, in turn, holds a 36.4% equity interest in Anhui Conch Cement.

China Conch Venture’s net profit attributable to shareholders was RMB3,469 million in the first half of the year, and its share of profit of associates amounting to RMB2,910 million in 1H 2020 accounted for 84% of the company’s bottom line. In the company’s 1H 2020 results announcement, China Conch Venture highlighted that “the share of profits of associates (were) mainly attributable to Conch Holdings.”

Also, China Conch Venture’s indirect equity interest in Anhui Conch Cement accounted for 86% of its market capitalization, based on China Conch Venture’s and Anhui Conch Cement’s market capitalizations of HK$325 billion and HK$67 billion, respectively as of October 14, 2020. Earlier, I have written about Anhui Conch Cement in an article published on April 20, 2020.

Excluding China Conch Venture’s associate company Conch Holdings and its indirect stake in Anhui Conch Cement, the Energy Preservation and Environmental Protection Solutions segment is the most important business for China Conch Venture, contributing 92% of its 1H 2020 revenue. According to its 1H 2020 results announcement, China Conch Venture’s Energy Preservation and Environmental Protection Solutions business has “71 solid waste treatment projects, 50 grate furnace power generation projects, 16 projects of waste treatment by cement kilns and 2 foul water treatment projects” as of August 25, 2020. The company’s annual treatment capacity for industrial solid & hazardous waste is approximately 7.86 million metric tons, while its annual treatment capacity for municipal waste is roughly 12.50 million metric tons.

I will be focusing primarily on China Conch Venture’s solid & hazardous waste treatment business for the purpose of this article, as this business is a key earnings contributor (excluding share of profits of associate) and a spin-off candidate (detailed in a subsequent section of this article) as well.

Strong 1H 2020 Results, Albeit With Some Weak Spots

China Conch Venture announced the company’s 1H 2020 financial results on August 25, 2020, and its financial performance was strong. The company’s net profit attributable to equity shareholders grew by +10.4% YoY, from RMB3,141 million in 1H 2019 to RMB3,469 million in 1H 2020, as it benefited from a +7.3% YoY increase in share of profit of associates (mainly Conch Holdings and Anhui Conch Cement) from RMB2,712 million to RMB2,910 million over the same period.

Notably, China Conch Venture’s net profit of its principal activities (environmental protection solutions & energy preservation, building materials and port logistics services) attributable to equity shareholders jumped by +30.1% YoY to RMB558 million in the first half of the year, while its top line grew by +33.9% YoY to RMB2,817 million in 1H 2020.

Specifically, segment revenue and operating profit for China Conch Venture’s Energy Preservation and Environmental Protection Solutions business increased by +37.5% YoY and +29.6% YoY to RMB2,667 million and RMB 732 million, respectively in the first half of this year. This was driven by a +54.5% YoY increase in hazardous waste received to 156,700 metric tons and a +57.7 YoY increase in general solid waste received to 269,900 metric tons in the first half of the year. China Conch Venture also secured 21 new solid waste treatment projects with a total annual production capacity of 2.14 million metric tons year to date.

On the flip side, there are certain weak spots within its 1H 2020 results that are noteworthy.

Firstly, the gross profit margin of the solid waste solutions business within the Energy Preservation and Environmental Protection Solutions segment contracted by -733 basis points to 66.52% in 1H 2020. At the company’s 1H 2020 results briefing (audio recording and transcript not publicly available) in late August 2020, China Conch Venture explained that a full six months’ contribution from the Chongqing project with relatively lower pricing (the new project only contributed one month’s of earnings in 1H 2019) and an increase in transportation costs were the key reasons for the the solid waste solutions business’s gross margin contraction.

Secondly, China Conch Venture’s net cash generated from operating activities more than halved from RMB143 million in 1H 2019 to RMB70 million in 1H 2020. This was primarily attributable to the increase in trade and other receivables relating to a rise in government subsidies associated with more power generation projects commencing operations and a slower pace of payments from the government associated with the solid & hazardous waste treatment business.

Thirdly, China Conch Venture has revised its FY 2020 guidance for hazardous waste received and general solid waste received downwards (as compared to initial guidance in early 2020) by -33% YoY and -12% YoY to 504,200 metric tons and 846,100 metric tons, respectively. COVID-19 and associated project delays have led to the downward revision in FY 2020 guidance. On the positive side of things, the new guidance suggests strong growth in 2H 2020, as China Conch Venture’s hazardous waste received and general solid waste received were only 156,700 metric tons and 269,900 metric tons, respectively in 1H 2020.

Potential Spin-offs To Narrow Conglomerate Discount And Unlock Value

As highlighted above, China Conch Venture’s indirect equity interest in Anhui Conch Cement accounted for 86% of its market capitalization. This implies that the market is valuing the company’s core businesses (e.g., energy preservation and environmental protection solutions, building materials and port logistics services) at a relatively conservative high-single digit earnings multiple based on my estimates. This is not surprising, considering that China Conch Venture, with its interests in multiple businesses, has a significant conglomerate discount assigned to the stock.

China Conch Venture disclosed at its recent 1H 2020 results briefing that it has plans to spin off its solid & hazardous waste treatment business and waste-to-energy/power generation business in the next few years. The company hopes to spin off and list its solid & hazardous waste treatment business on the Hong Kong Stock Exchange in the second half of 2021 or the first half of 2022, while it is targeting a China A-share listing for its waste-to-energy/power generation business in either 2021 or 2022.

Notably, China Conch Venture highlighted at the company’s 1H 2020 results briefing that it wishes to list the solid & hazardous waste treatment business at implied P/E multiples of 25-30 times, so the exact timing of the solid & hazardous waste treatment business IPO will be dependent on how fast the earnings of this business ramp up to a certain scale.

Risk Factors

The key risk factors for China Conch Venture are weaker-than-expected gross margins for its solid waste solutions business going forward, a further decline in operating cash flow due to growing receivables, and a delay in the planned spin-offs of its solid & hazardous waste treatment business and waste-to-energy/power generation business.

Note that readers who choose to trade in China Conch Venture shares listed, as ADRs on the OTCBB (rather than shares listed in Hong Kong) could potentially suffer from lower liquidity and wider bid/ask spreads.

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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